IAS 2 Inventories

Definitions &
Recognition
Definitions

Inventories are assets:

– Held for sale in the ordinary course of business;
– In the process of production for such sale; or
– In the form of materials or supplies to be consumed
in the production process or in the rendering of
services.
Inventories can include any of the following.
Goods purchased and held for resale, eg goods held
for sale by a retailer, or land and buildings held for
resale
Finished goods produced
Work in progress being produced
Materials and supplies awaiting use in the production
process (raw materials)
Cost of inventories

The cost of inventories will consist of all costs of:

Purchase
Costs of conversion
Other costs incurred in bringing the inventories to
their present location and condition
Costs of purchase

The standard lists the following as comprising the costs of

purchase of inventories.
Purchase price PLUS
Import duties and other taxes PLUS
Transport, handling and any other cost directly
attributable to the acquisition of finished goods, services
and materials LESS
Trade discounts, rebates and other similar amounts
Costs of conversion

Costs of conversion of inventories consist of two main

parts.
a) Costs directly related to the units of production, eg
direct materials, direct labour
b) Fixed and variable production overheads that are
incurred in converting materials into finished
goods, allocated on a systematic basis.
 Ex1
IAS 2 Inventories specifies expenses that should be included in year-
end inventory values. These could include:
A. Marketing and selling overhead
B. Variable production overhead
C. General management overhead
D. Factory management overhead allocated to production
E. Cost of delivering raw materials to the factory
F. Abnormal increase in overhead charges caused by unusually low
production levels due to the exceptionally hot weather.
Which THREE of the above are allowable by IAS 2 as expenses
that should be included in the cost of finished goods inventories?
 Ex1
Answer B, D, E
IAS 2 states that:
a. selling costs cannot be included in inventory cost, therefore item A
cannot be included
b. general overheads cannot be included (item C)
c. overhead costs should be added to inventory cost on the basis of
normal capacity of the production facilities, therefore item F cannot
be included in cost
d. the cost of factory management and administration can be included,
so that item D can be included in inventory values.
 Ex2
Mario has incurred the following costs in relation to a unit of
inventory:
Raw materials cost 1.50
Import duties 0.40
Direct Labour 0.50
Subcontracted labour costs 0.80
Refundable sales tax 0.20
Storage costs 0.05
Production overheads (per unit) 0.25

There was a problem with the first batch of items produced, so abnormal
wastage costs of 0.10 per unit have also been incurred by Mario.
 Ex2
At what value should Mario value this inventory in its Financial
Statements?
A. $3.50
B. $3.45
C. $3.80
D. $3.70
 Ex2
Answer B
The costs of inventory should include all costs of bringing inventory
to its present location and condition, so Mario should include the raw
materials cost, import duties, direct labour, subcontracted labour and
production overheads in its inventory.
Sales tax would not be included as it is refundable.
Storage costs are specifically excluded from the value of inventory, as
they are incurred once the inventory is ready to be sold.
Abnormal wastage costs are excluded from the valuation of inventory
per IAS2.
Cost formulae

The cost of inventories should be assigned by using

the first-in, first-out (FIFO) or weighted average
cost formulas. The LIFO formula (last in, first out)
is not permitted by IAS 2.
Net realisable
value (NRV)
Measurement of inventories

IAS 2 Inventories states that 'Inventories

should be measured at the lower of cost and
net realisable value.'
 Ex3
On 30 September 20X4, Razor's closing inventory was counted and
valued at its cost of $1 million.
Some items of inventory which had cost $210,000 had been damaged in
a flood (on 15 September 20X4) and are not expected to achieve their
normal selling price which is calculated to achieve a gross profit margin
of 30%.
The sale of these goods will be handled by an agent who sells them at
80% of the normal selling price and charges Razor a commission of 25%.

At what value will the closing inventory of Razor be reported in its

statement of financial position as at 30 September 20X4?
$ .
 Ex3
Answer $970,000
The normal selling price of damaged inventory is $300,000 (210/70%).
This will now sell for $240,000 (300,000 x 80%), and have a NRV of
$180,000 (240 - (240 x 25%)). The expected loss on the inventory is
$30,000 (210 cost - 180 NRV) and therefore the inventory should be
valued at $970,000 (1,000 - 30).
 Ex4
Neville has only two items of inventory on hand at its reporting date.
Item 1 - Materials costing $24,000 bought for processing and assembly
for a customer under a 'one off’ order which is expected to produce a high
profit margin. Since buying this material, the cost price has fallen to
$20,000.
Item 2 - A machine constructed for another customer for a contracted
price of $36,000. This has recently been completed at a cost of $33,600. It
has now been discovered that, in order to meet certain health and safety
regulations, modifications at an extra cost of $8,400 will be required. The
customer has agreed to meet half the extra cost.
What should be the total value of these two items of inventory in the
statement of financial position?
$ .
 Ex4
Answer $55,800
Cost Recoverable amount Lower of cost and
(Net Realisable Value) recoverable amount
Item 1 $24,000 See note 1 $24,000
Item 2 $33,600 $31,800 (note 2) $31,800
$55,800
Notes:
The recoverable amount is not known, but it must be above cost because the contract is
expected to produce a high profit margin. The subsequent fall in the cost price to $20,000
is irrelevant for the inventory valuation.
The recoverable amount is $36,000 minus 50% of $8,400.
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